As the trees begin to turn and the holidays approach, it’s time to turn your thoughts to reducing the size of your 2009 tax bill next spring.
The most common tactics used in year-end tax planning include taking advantage of available federal and state income tax credits and shifting taxable income between years by controlling the receipt of income or payment of deductions.
It is usually most advantageous to shift income into the year with the lower marginal tax rate, while deductible expenses should be paid in the year with the higher marginal rate. If you anticipate your top tax rate will be about the same in 2009 and 2010, deferring income into 2010 and accelerating deductions into 2009 will generally produce a tax deferral of up to one year. The decision to delay income during the last few months of the year, however, becomes more difficult in our present economy, because deferring income sometimes runs the risk of not receiving it at all.
Moreover, for higher income taxpayers, it may not be advisable to defer income beyond 2010, as many observers expect the top tax rates on ordinary income to increase in 2011. Long-term capital gains rates could increase as well, so it might be advisable to take large profits (assuming there are any of those left) this year or in 2010.
On the other hand, the conventional approach of accelerating deductions or generating credits becomes more urgent in 2009 because many of the tax breaks enacted in the recent stimulus packages will expire at the end of this year. As I write this, there are rumblings in Washington that the very popular first-time home buyer credit could be extended beyond its current Nov. 30 expiration date.
In order to take advantage of a host of other expiring tax breaks, however, action is required before the end of the year. For individuals, these expiring provisions include the standard or itemized deduction for state sales tax and excise tax on the purchase of motor vehicles; the deduction for qualified higher education expenses of up to $4,000; tax-free distributions from IRAs for charitable purposes for IRA owners 70.5 or older; and the $250 deduction for teachers’ classroom expenses.
Expiring business provisions include the 50-percent bonus first year depreciation for most new machinery, equipment and software; the unusually high $250,000 “Section 179” expensing provision for qualifying purchases of new or used property; the five-year write-off for most farm equipment; and the 15 year write-off for qualified leasehold improvements. Accelerating qualifying expenses into 2009 to take advantage of these incentives rather than incurring them in 2010 could have a significant impact on your tax bill.
Any discussion of year-end tax planning would be remiss if it failed to address the potential impact of the alternative minimum tax. The AMT was originally enacted to prevent the very wealthy from availing themselves of loopholes to avoid paying taxes. Because these provisions were not designed to keep pace with inflation, unlike regular income tax, more middle-income taxpayers are finding themselves caught up in the AMT every year.
For the middle-income taxpayer, the alternative minimum tax can be triggered by many items: large capital gains; large deductions for state, local, personal property and real estate taxes; large amounts of miscellaneous itemized deductions; large numbers of personal exemptions; and large deductible medical expenses.
Taxpayers in the AMT find themselves subject to a set of rules completely separate from the regular income tax system. As a result, these taxpayers require a different planning approach during the last few months of the year because some of the most basic year-end strategies can have unintended consequences. For example, accelerating certain deductions into an AMT year can be a fruitless maneuver because these deductions are of no benefit under the AMT rules. Similarly, many tax credits available under the regular income tax system aren’t allowed against AMT. It is extremely important, therefore, to be able to anticipate which taxing system will be determining your tax liability.
There is no question that year-end tax planning is getting more complicated. During this period of change in our economy and tax laws, it is increasingly difficult to project one’s marginal tax rate for the current and future years, as well as determine in which years the AMT might come into play. Furthermore, it is necessary to take into account each taxpayer’s unique situation when developing planning strategies.
While most taxpayers will benefit by following the traditional approach, others with special circumstances will find it more advantageous to accelerate income and defer deductions. Nevertheless, there are many actions you can take before year-end to lower your tax burden. If you haven’t done so already, now is the time to start the year-end planning process.
Patrick Milligan, CPA, PFS, is a tax partner at HoganTaylor LLP.